28 Dec Pension Risk Transfer Considerations – Time to insulate yourself by removing unknowns?
Frozen pension plans face recurring costs and perpetual exposures in the form of rapidly increasing Pension Benefit Guarantee Corp (PBGC) premiums, on-going administrative and money management fees, and updated mortality tables incorporating longer participant life expectancies. With inherently precarious pension liabilities exposed to pervasive risks from increasing longevity, investment performance, and interest rate fluctuations, plan funding status can deteriorate abruptly.
With inherently precarious pension liabilities exposed to pervasive risks plan funding status can deteriorate abruptly.
The funding status of plans has improved recently as strong investment returns have offset the liability-expanding negative of low interest rates. At this juncture, however, elevated asset prices may reflect the pull-forward of future investment returns, while many experts see structural forces keeping interest rates ‘lower for longer.’
With improved funded status, plan sponsors face an increasingly asymmetric risk and reward profile. Those retaining risk assets as funded status improves receive diminishing economic benefits as excess funds cannot be used for other, more productive, business purposes . . . while downside risk grows. Equity markets also possess asymmetric characteristics. Valuation metrics show the stock market to be richly valued today, as unprecedented quantitative easing has provided a protracted period of favorable returns amid benign volatility and no meaningful correction. How will a reversal of asset-inflating quantitative easing play out? Stay tuned – it’s just now getting underway.
Companies concerned with the risks entailed in their pension plans can transfer some-most-all of their obligations either by purchasing an annuity from a highly-rated insurer to cover future payments to a group of retirees, or by offering lump-sum buyouts to participants. Many are considering using existing resources and/or borrowing capacity to transfer pension risk while borrowing costs remain reasonable. These fiduciaries increasingly reject ‘Hope’ as a strategy, believe the cost of lump sum buyouts will increase with time, and that lower income tax rates increase the after-tax cost of pension contributions.
These fiduciaries increasingly reject ‘Hope’ as a strategy, believe the cost of lump sum buyouts will increase with time, and that lower income tax rates increase the after-tax cost of pension contributions.
Sponsors with well-funded plans may want to consider a pension buy-out to meaningfully reduce risk. Many are focusing on transferring liabilities associated with retiree populations, which are the most efficient to buy out. That’s because the PBGC’s per-participant premiums are increasing annually, and underfunded plans incur an additional variable-rate premium on unfunded vested benefits. These additional variable-rate premiums can equate to hundreds of dollars annually per participant, which augurs for small-benefit buyouts for retirees.
Other sponsors with limited de-risking budgets could also target retiree buy-outs or borrow opportunistically to bolster their plan’s funded position before embarking on a de‑risking journey. A borrow-to-fund strategy can replace volatile, expensive, pension liabilities with lower cost, fixed‑rate, obligations.
Interest in pension risk transfer (PRT) continues to intensify among U.S. defined benefit pension plans, as plan sponsors explore ways to reduce both balance sheet liabilities and funded status volatility. Experts expect domestic plans to purchase $20 Billion of annuities in PRT transactions in 2017, with significantly more in 2018 as plans enhance their funded status. Meanwhile, a recent industry survey showed 75% of plan sponsors were considering or planning lump sum offers.
Many plan sponsors have found responsibly ‘exiting the pension business’ to be highly liberating . . . and constructive in the sense it keeps the focus on creating value.
Many plan sponsors with adequately-funded situations have found responsibly ‘exiting the pension business’ to be highly liberating . . . . and constructive in the sense it keeps the focus on creating value. Proactive plan fiduciaries continue to consider options for insulating themselves by removing unknowns.
When should a company consider de-risking its pension obligations? Probably “when it can.” Studies suggest the likelihood of sponsors ‘earning’ their way to fully funded status is remote; contributions to the plan (at greater after-tax cost) will be required over time . . . while all-in ongoing administrative costs comprise an inefficient and perhaps unnecessary burden. Discharging fiduciary responsibilities entails more than merely following prudent investment practices. Proactive stewardship requires on-going consideration of all options, including funding levels and PRT options.
When should a company consider de-risking its pension obligations? When it can.
My team specializes in transferring pension liabilities and their potential to escalate away from plan sponsors and we do so in the most efficient manner possible. We have the experience, knowledge and partnerships in place to deliver solutions capable of reducing both cost and risk, thereby benefitting pension plans and their Trustees, sponsoring companies, and people.